By David Adonri
There are two categories of investors in the Capital Market. These are, institutional investors and retail investors.
Institutional investors are professional investment managers who deal in a large volume of securities. They move big money. Institutional investors include pension funds, mutual funds, insurance companies, investment banks, endowment funds, private equity investors and others. The money that institutional investors invest is not generally owned by them. In contrast, retail investors use their money to invest. Retail investors are non-professional market participants who generally invest small amounts of money than institutional investors. They usually trade in equities and bonds because of insufficient financial wherewithal to venture into capital intensive investments like private equity and hedge funds.
The retail investment market is enormous. Retail investors have a significant impact on capital market sentiment which represents the overall tone in the financial market. Without the massive participation of retail investors in the Nigerian capital market, the indigenization exercises of the 1970s and the banking sector consolidation programme of 2005 would not have succeeded. However, retail investors suffered serious calamity in 2008 when the global meltdown crystallized their over-concentration risk in equities. Being poorly informed then, many retail investors concentrated their portfolio of investments on just one asset class, namely equities. Since 2009 when major reforms occurred in the Nigerian capital market, things have changed. Retail investors now have access to more financial information, investment education and trading tools than ever before.
Mobile trading, using smartphone, now enable retail investors to buy and sell securities by themselves, react immediately to changing market conditions and take control of their portfolio of investments. Considering the unhindered access that retail investors now have to determine their fate in the capital market, critics are no longer justified in the notion that retail investors lack prerequisite competence to play the market. What is lacking may just be the discipline, professional depth and devotion of time to research their investments like professional portfolio managers. Nonetheless, the tools for portfolio management are not far fetched. Advancement in fintech has placed the tools within the reach of every investor.
Portfolio management is concerned about the profitability, liquidity and safety of investments. These are the same broad objectives that retail investors seek when they buy and sell securities. What portfolio management offers is drilling down into the critical elements of planning which match objectives with the differentiated needs of the investor. This entails the careful selection of the best investment options and overseeing them in order to meet the long term financial goals and risk tolerance of an investor. Professionally licensed portfolio managers (institutional investors) work on behalf of other investors while individual or retail investors may choose to build and manage their own portfolios. In either case, the investor’s ultimate goal is to maximize the investment’s expected returns within an appropriate level of risk exposure.
Portfolio management starts with the profiling of an investor. This is to uncover the investor’s age, income, investment goal, time horizon and risk tolerance level. From the profile, an investment plan can be formulated. The plan is made up of the objective, strategies, implementation and evaluation agenda. The objective will indicate whether the portfolio aims at growth or income or preservation of capital or a balanced portfolio. Selecting the securities that match objectives require product knowledge and analysis of liquidity and market risks. Infact, investment analysis is the key to a sound portfolio management strategy. It is the broad term for many different methods of evaluating securities, industry sector and economic trends. The aim of investment analysis is to determine how an investment fits into the objective of the portfolio.
After thorough analysis of the fundamentals and historical price movement of the selected financial assets, fund is allocated with the aim of constructing a diversified portfolio. Based on the investment objective, a diversification strategy is deployed to ensure that the portfolio contains a mix of different asset classes (equities, debt and cash equivalents) and/or alternative investments such as real estate, commodities and derivatives. Diversification is a risk management strategy that mixes a wide variety of non-correlated investment assets within a portfolio. A diversified portfolio contains a mix of distinct asset types in an attempt to limit exposure to any single asset or risk.
The idea is that the positive performance of some assets in the portfolio will neutralize the negative in others. If Nigerian retail investors diversified their portfolios then, the heavy losses they incurred when the equities market crashed during the global meltdown in 2008 would have been averted. After diversification, available fund is allocated to each asset in the portfolio based on appropriate weighting ratio that satisfy the objective of the plan. In the course of time, if the weighting ratio falls apart, rebalancing is used to return the portfolio back to its original asset allocation mix.
The implementation of a portfolio management plan is done actively or passively. In active portfolio management, securities are bought when they are undervalued and sold when their value increases. This strategy aims at outperforming the market. The success of an actively managed portfolio depends on a combination of in depth research, market forecasting, modelling and trading expertise
which may be beyond the capacity of many retail investors. This is why many of them embrace the passive portfolio management approach. The strategy is based on constructing a portfolio that aligns perfectly with the composition of an index for long term investment. It aims at duplicating the returns of the index. A passive portfolio can also be structured like Exchange Traded Fund (ETF), mutual fund or investment trust fund. Implementation also requires investors to set a floor for their position in a security via a “Stop -Loss” order to sell if price falls to a limit. The final step in portfolio management involves periodic evaluation of performance of the portfolio and if necessary, review of the overall investment strategy.
While portfolio management is best performed by institutional investors, the fact that the exercise enable investors to develop the best customized plan that matches their profile with risk tolerance, makes it to be essential for every retail investor who is undertaking an investment venture in the capital market.